Crowdfunding (or crowd financing, equity crowdfunding, crowd-sourced fundraising) is a way to raise business finance by accessing a pool of money sourced from many people wanting to invest small amounts. Crowdfunding sites have become popular during the recent global recession when other sources of business finance have been difficult to use, e.g. bank loans.

Until recently, financing a business, project or venture involved asking a few people for large sums of money. Crowdfunding switches this idea around, using the internet to talk to thousands – if not millions – of potential funders. Typically, those seeking funds will set up a profile of their project on a website. They can then use social media, along traditional networks of friends, family and work acquaintances, to raise money.

In 2012 there were over 450 crowdfunding sites all providing different services. As a project leader seeking finance from a crowdfunding service you should always do your own due diligence to understand which platform is the best to use based upon the nature of the project you are working on.

Types of crowdfunding sites

There are three different types of crowdfunding sites: donation, debt and equity.

1. Donation/Reward crowdfunding sites

People invest simply because they believe in the cause. Rewards can be offered (often called reward crowdfunding), such as acknowledgements on an album cover, tickets to an event, regular news updates, gifts and so on. Returns are considered intangible. Donors have a social or personal motivation for putting their money in and expect nothing back, except perhaps to feel good about helping the project.

2. Debt crowdfunding sites

Investors receive their money back with interest. Also called peer-to-peer (p2p) lending, it allows for the lending of money while bypassing traditional banks. Returns are financial, but investors also have the benefit of having contributed to the success of an idea they believe in. In the case of microfinance, where very small sums of money are leant to the very poor, most often in developing countries, no interest is paid on the loan and the lender is rewarded by doing social good.

3. Equity crowdfunding sites

People invest in an opportunity in exchange for equity. Money is exchanged for a shares, or a small stake in the business, project or venture. As with other types of shares, apart from community shares, if it is successful the value goes up. If not, the value goes down.

Digital finance resources

Top crowdfunding sites

With more than 63,000 projects and $250 million in pledges raised, Kickstarter has emerged as a leader in the current crowdfunding craze. There has been a lot of buzz about whether they will start helping their users offer equity to investors once the new rules are in place. But in a recent interview with GigaOm, founder Perry Chan stated that Kickstarter is “not interested in that model.”

Like Kickstarter, Indiegogo is a popular crowdfunding site that recently raised $15 million in Series A funding. The company claims that this is the largest funding round of any crowdfunding platform to date. Indiegogo was a supporter of the JOBS Act, and founder Slava Rubin told TechCrunch that the company may very well decide to open up the platform to equity transactions in the future.

Founded by serial entrepreneur Wil Schroter, Fundable is currently running a rewards-based funding platform while also offering accredited investors the opportunity to invest in small business for equity. Schroter plans to fully open the gates as an equity crowdfunding site once the government has implemented the JOBS Act.

This Los Angeles-based company has taken a different approach to waiting out the JOBS Act rules before it can start offering equity through the site. Companies can apply to raise funds and users can vote on those they would invest in without any transactions actually taking place. As of the end of May, nearly 2,000 companies had signed up with crowdfunders pledging $17 million in investments. Crowdfunder is also holding a series of contests in cities around the country where a panel of investors judge local businesses and they compete for $25,000 in funding. The first event, called Crowdstart LA, took place on May 22nd and elicited over 700 submissions.

In an effort to raise awareness about the JOBS Act and educate consumers about its benefits, EarlyShares recently announced a U.S. tour, hitting 24 cities in 24 weeks on a Nationwide Educational Roadshow. The company is also co-sponsoring Techweek Launch, a startup competition that offers one winner up to $100,000 in cash and prizes. Although the company claims it is “the premiere Portal for Equity Based Crowdfunding” they say they can’t list real companies on the site and are only taking pre-registrations.

Once the rules are in place early next year, private businesses and startups will be able to use crowdfunding to give equity to investors who will get an actual monetary return instead of a sticker or T-shirt.

Launched by a group of young Wall Street alums getting their MBAs at The Wharton School of the University of Pennsylvania, SeedInvest recently won third place at Philly Startup Weekend 3.0. Founder Ryan Feit said that following their win, he’s had a lot of people from the Philadelphia community reach out to him about investing and is in the process of seeking a round of funding. The site is still in the pre-launch phase but entrepreneurs and business owners can apply for early access.

A group of venture capitalists, entrepreneurs and investment bankers have teamed up to launch RelayFund, set up by investment banking firm Hartwick Capital and investor relations firm Lambert, Edwards & Associates. According to a press release, the founders view crowdfunding for equity as “the next major catalyst in transforming the capital markets and connecting everyday Americans with private equity.” The press release also calls RelayFund “a leading online community focused on second-generation crowdfunding…” but the crowdfunding site has yet to launch.

Founded in January 2010 by an MIT Sloan School of Management grad and still in pre-launch, WeFunder boasts 6,100 funders pledging more than $16.5 million in investments. According to Mashable, the platform combines traditional startup funding with equity crowdfunding in amounts as low as $100.

Equity-based crowdfunding is already legal in the UK, and CrowdCube has been around for a few years already. They have raised £2.8 million for 15 companies so far. The company has not announced any plans to expand into the U.S. market but given their experience compared to these new domestic players, they are positioned well to do so.